I don’t know if you had the same reaction to Paul Krugman’s latest column on financial reform as I did:
The only question is whether we’re going to regulate bankers so that they don’t abuse the privilege of government backing. And it’s that regulation — not future bailouts — that reform opponents are trying to block.
but I found it remarkably content-free. Other than the regular “Republicans—bad” mantra, Dr. Krugman doesn’t appear to have a great deal to say on the subject.
If you derived all of your information on the financial crisis from reading Dr. Krugman’s column, you might not realize that over the last 30 years or so bank deregulation has proceeded apace under Democratic and Republican presidents, Democratic Congresses and Republican alike. So, the Depository Institutions Deregulation and Monetary Control Act, a substantial deregulation of the banking system which set the state for the megabanks of today, was enacted under President Carter with both houses of the Congress solidly in Democratic hands. The repeal of Glass-Steagall in the form of the Gramm-Leach-Bliley Act took place under President Clinton and a Republican-controlled House. Dr. Krugman archly refers to bank deregulation as having taken place “since the 1980’s or so” but taking place in 1980, as the DIRMCA did, is different from taking place in 1981 or later.
Bank deregulation has been bipartisan.
The other peculiar thing about the column is that neither Dr. Krugman nor anybody else urging increased regulation as a means for preventing future meltdowns seems to be able to point to a “smoking gun”, some specific regulation which, if it had been in place, would have prevented the greatest financial crisis since the 1930’s. The conundrum is exacerbated to some extent by the reality that it was a worldwide financial crisis. Were European regulations inadequate as well?
Quite to the contrary the accounts that I’ve heard seem to suggest that all of the regulations needed to prevent the crisis were already in place and the regulators had the power to enforce them. They were simply disinclined to take action.
If a disinclination to enforce regulations already on the books was, indeed, the case will giving the Fed additional powers or creating a new commission independent of the Fed achieve the stated goal? Or will it merely give regulators a higher platform from which to do whatever it is they were doing instead of regulating the financial industry?
“Other than the regular “Republicans—bad†mantra, Dr. Krugman doesn’t appear to have a great deal to say on this, or any other subject.”
FIFY
Actually, I’m beginning to find Krugman’s vacuity alarming, or at least I’m finding the fact that so few people seem to realize there is nothing there these days alarming.
I’ve heard it argued that one of the problems has been that the banks have been simply better (i.e. smarter, craftier, etc.) than those assigned to regulate them. To change that would probably require someone to take hold of the regulatory agencies the way Hoover did the FBI. A little esprit de corps from those folks couldn’t hurt.
Interestingly, Rich, there’s a rather impressive body of scholarship that suggests that policy will always fail when dealing with intelligent actors. Steve Verdon may drop by and drop the link for this. It’s around here some place.
Both parties have been complicit in some of the rule changes. The Republicans were just more willing to hire people like John Dugan. If leverage requirements had been left higher, that might have made it more difficult to achieve the current mess, other than that, you mostly correct. Deep capture is a bigger problem than just have regulators rotating in and out of the industry. When the regulators and regulated all agree that businesses should regulate themselves, you are in trouble.
I dont know if you are familiar with the book Snakes In Suits, but I believe the financial elite have a bunch of very bright sociopaths in their midst. The regulators will always be outgunned, especially now that corporations can use their money to directly influence political outcomes. I think we need to break them up and then have relatively few, but blunt regs. Then let them fail if they go bankrupt.
Steve
Forgot. Here’s the link on the special exemption for leverage for the investment banks. Konczal has some good stuff on it also.
http://bigpicture.typepad.com/comments/2008/09/regulatory-exem.html
Steve
Dang, must link, then hit submit. Here is Ritholtz on how deregulation, the total absence of regulation, contributed to AIG.
http://www.ritholtz.com/blog/2010/03/misunderstanding-the-last-financial-crisis/
Steve
In the case of AIG Ritholtz is mistaken.
I’ve posted on this subject before. An obscure federal agency (I’d have to poke around here to figure out which one) has acknowledged that they had the authority and the power to regulate AIG in such a way that it would have prevented the company’s failure. They just didn’t do it.
Dave,
It was the Office of Thrift Supervision (OTS). Here’s one account, but there are many on OTS admitting it failed to properly regulate AIG and other institutions.
I remember reading a story about the regulators who supposedly regulated Bernie Madoff’s ponzi scheme. It turns out they were invariably young and inexperienced and Madoff intimidated and belittled them to keep them from finding out what he was doing. These young regulators supposedly considered their current positions as stepping-stones to careers within the financial industry and so they were not interested in making too many waves for potential future employers, especially the supposed genius-kings like Madoff.
So I have to agree with Dave here – “more” regulation, as opposed to better regulation, is likely to make things worse than doing nothing.
Yes, I think that’s the one I was thinking of. Thanks, Andy.
As I’ve said before here, I think we’ve got to change the incentives for regulators so they’re more likely to do their jobs.
Andy and Dave-Thanks. I had totally forgotten that post. Creating incentives will be hard when the regulators believe the same things as the people they regulate. Better to downsize them and have a few bright line regs that are hard to get around.
Steve
What do you mean now?
Buchanan, Tullock, Niskanen, et. al. begain their work on nothing this kind of thing decades ago. This is not something new, it is something very old.
Can’t recall if it was Niskanen or Stigler that came up with the notion of regulatory capture. I’d take it a step further and say that our entire political process has been captured. Look around at both parties and you’ll see that very influential people on both sides have gotten very rich from “Wall Street”.
From your link steve,
Is that Timmy? Timmy G. the guy who helped bailout LTCM and helped get this ball bouncing? Yeah, lets rely on him.
Don’t forget the Benanke and Geithner were also involved in the failure to bailout Lehman after bailing out Bear Stearns. What message did this send? “Now we wont bail you out after we bailed out Bear Stearns and LTCM”? What do you think that did? Here’s hint:
p4nic.
So, we see that by first signalling years ago “we’ll bail you out” the reinforcing that with Bear Stearns, then suggesting, “No we wont” could Bernanke, Geithner and Greenspan have played a more significant role in up-ending our financial system? I think so.
No regulations will help this. None. These are acts of political favoritism to the well connected.
What makes it even more amusing is that if I were to say it about AIG, every stinking liberal here would eat it up with a spoon. When I say it about LTCM, Bear Stearns and Lehman most look confused and unsure what to write next, but it will probably concern a meaningless overhaul of regulations.
The point is…its all the same process here. AIG, LTCM, Bear Stearns, TARP, etc. are all part of the same game. One designed to benefit Wall Street by having taxpayers underwrite Wall Street’s excess risk taking. Will we have another financial meltdown. Absolutely.
I also disagree with Ritholtz calling it redical deregulation or whatever. Swaps and other financial derivatives were not regulated by the CFTC because they looked at them like forward delivery contracts vs. future delivery contracts.
(See here for a discussion of futures vs. forward contracts).
It wasn’t a case of deregulation, but one of regulation never really being in place and once the various swap markets got to a certain size trying to regulate them was problematic since it could have negated prior contracts leaving various entities open to risk they thought they had reduced/eliminated via these swaps.
Of course, while his lead up is, in my view, misleading this is the right conclusion. Wall Street didn’t want the oversight and they got it…via guys like Robert Rubin as well as others. Still calling a failure to even start regulating radical deregultion is to abuse the english language in an almost x-rated manner.
As for the problems with intelligent forward looking agents there is indeed quite a bit of literature on this. For example the issue of time inconsistency that Kydland and Prescott won their Nobel for shows that discretionary policy doesn’t work even absent things like craven politicians pursuing their own agendas. The public choice literature that looks at things like regulatory capture, and other issues indicates that there are serious problems with relying on government to stop these things. Hell even the incentive theory suggests that the government has problems. Yeah the government can watch over the financial industry, but then who watches the government? Voters? Pardon me while I fall down laughing.
1) I am in agrement with the conclusion also. I think the way to go then, is to reduce the size of these institutions so that the systemic shock of a failure is lessened. I would then have fewer regs, but make them bright line ones. Set leverage ratios at some hard number, no exemptions. Once that is done, no bailouts The timing on this will be difficult. Breaking up banks in the middle of a recession is iffy IMHO.
My biggest concern then, remains the big internationals. IIRC, Continental, the big Illinois bank was the largest we put through resolution prior to this crisis. We have never had to go through a bankruptcy of one of the big internationals. I do not think we have the means to do so. The politics would be awful since we do not seem to feel the need to worry much about international law. Since those big banks also control most of the credit card markets and everyday things like our ATMs, what would really happen if they went through BK proceedings, all at the same time like we were looking at?
2) How much obligation does a country have to guarantee its financial system? I think that given our reliance upon credit and the velocity with which money now moves, it is nearly impossible for governments, not just ours, to not offer implicit guarantees of the safety of their financial systems. I think our international trade is severely hampered without that guarantee. I am open to counterargument here, but I find it difficult to see it working otherwise.
3) On capture, I refer not just to ordinary capture, regulators moving to work for the companies they regulate once out of office. I also refer to deep capture. The idea that they all think alike, all share the same philosophy.
4) “What do you mean now?” I was obliquely referring to corporate free speech. Business execs will no longer have to work through intermediaries. Besides influencing the legislative process, they can now influence public opinion more directly.
“Yeah the government can watch over the financial industry, but then who watches the government? Voters? ”
Then we are just all screwed.
Steve
Pretty much. It is why I keep harping on the idea of how awful democracy is. Sure it beats other forms of government, but that is like saying I can beat up a 2 year old. Nothing to be impressed with, nor to brag about. We’ve moved a vast amount of our economy under the auspices of democracy and we seem wholely inclined to keep doing so hoping there is a pony in there somewhere despite repeatedly failing to find one.
Could things be better? Sure, but then you’d have to ask those currently in power to do things that would bring about the end of that power, and they simply wont do that, IMO.
And by screwed I don’t mean we are going to get some kind of 1984 style government we’ll just end up with the soft tyranny as described by de Toqueville at the end of his book, and most people will like it that way. Being taken care of is so much easier than taking care of yourself.